RBI Holds Rate But Says Open to Cuts

 

In line with market expectations, the Reserve Bank of India (RBI) on Tuesday kept the key interest rate unchanged at 7.25 per cent at its third bi-monthly review of monetary policy. The central bank cited uncertainties related to the monsoon and a spike in core inflation.

It, however, added it would monitor developments pertaining to room for more rate cuts.

On Tuesday, domestic equity markets snapped a four-day winning streak, as investors turned cautious. The BSE Sensex and the National Stock Exchange Nifty fell 0.41 per cent and 0.31 per cent to 28,071.93 and 8,516.90, respectively

"Most worrisome is the sustained hardening of inflation, excluding food and fuel. More, the full effects of the service tax increase, which took effect from June, will feed through the rest of the year," RBI, which reduced the repo rate by a combined 75 basis points since January, said in a statement, adding prices of protein items had increased sharply in recent months.

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In June, Consumer Price Index-based inflation rose for the second consecutive month, increasing to a nine month high of 5.4 per cent. RBI expects inflation to fall in July and August, primarily due to a favourable base, the effect of which will wane from September.

The central bank revised its inflation projection for March-end from six per cent to 5.8 per cent.

RBI Governor Raghuram Rajan said the central bank was "comfortable" with the pace of disinflation, adding it would monitor the rainfall in August "very carefully". "We held the policy rate at 7.25 per cent as we await data on whether the recent increases in inflation, including non-food, are temporary and whether the monsoon will continue to be near-normal," Rajan said in a post-policy interaction.

"We note a recent fall in oil prices, which will be very beneficial for India. As we await the transmission of our front-loaded past actions, we will monitor developments for emerging room for more accommodation," he added.

Bankers have interpreted the central bank's forecast as a sign that rate cuts are possible on the back of softening inflation. "RBI's forward guidance clearly spells out the possibility of more monetary accommodation. In our view, though such action will be data-dependent, there seems to be a bias towards further rate cuts. The lowering of the inflation projection by RBI in the last quarter is an acknowledgement of a benign inflation trajectory," said Arundhati Bhattacharya, chairman of State Bank of India.

While RBI said rainfall was near-normal so far, there is uncertainty on the road ahead, with the predictions of the India Meteorological Department and Skymet, the two leading weather forecasters, showing a wide difference.

While cautious on inflation, the central bank said growth was "work in progress", adding the outlook was gradually improving. Here, too, a lot would depend on the monsoon, it said, as favourable real income effects could accrue from weaker commodity prices and a possible boost in agricultural activity if monsoon conditions improved. RBI retained its growth projection for this financial year at 7.6 per cent.

The central bank believes credit demand will improve from October and banks will see more gains ahead.

Bond markets were, however, disappointed, with yields inching up a few basis points. This was primarily because there were expectations the foreign portfolio investment limit in government securities would be increased.

Industry, too, expressed disappointment.

Confederation of Indian Industry (CII) Director-General Chandrajit Banerjee said in the prevailing situation, a cut in the policy rate would have gone a long way towards reviving the investment cycle, as credit demand was still weak.

"Going forward, CII expects the spotlight would be shifted towards growth and RBI would resume monetary easing in its next monetary policy, when hopefully, there would be much more clarity about the inflation trajectory," he said.

The central bank's next policy review is scheduled for August 29.

Reference - http://www.business-standard.com/article/finance/rbi-holds-rate-but-says-open-to-cuts-115080500035_1.html